Auditor Anthony Mukumbwa has commended that the private member Bill tabled by Member of Parliament Kusamba Dzonzi, which targets setting up a ceiling of interest rates charged by banks to a maximum of 5% above the Policy Rate set by the Reserve Bank, should be fully supported by every MP, who cares about people they represent.
In summary, the Bill also seeks to regulate and regularize setting up a ceiling of total interest charged to customers by banks to not exceed the capital borrowed and setting up a floor of interest paid to depositors to the higher of 2% above ruling inflation rates or 5% below the lending rate.
“There are many other good provisions that the Bill carries,” writes auditor Mukumbwa. “At the moment banks are squeezing growth of industries because of exorbitant interest rates charged forcing companies not to borrow which squeezes growth.
“Note also that high interest rates have resulted in high commodity prices because vendors borrow money for trading and this impacts on levels of inflation too. Once companies default due to high cost of borrowing which normally overtakes company profitability, the companies scale down operations and eventually close down resulting in untold suffering of employees and their suffering.
“Imagine interest charged can accumulate to high as 1,000% of capital borrowed making repayment impossible even if one wants to continue operating with the aim of repaying the loan. Remember they use compound interest system i.e. interest on interest.
“If you default for whatever unforeseen reason in most cases being high loan repayment levels, the interest can accumulate to over 10 times the capital borrowed. This results in people losing property to banks and throwing borrowers into financial crisis and misery.
“You would think this extra interest income made by banks is paid to depositors, NO. They keep that income resulting in billions of profits being declared. No bank lends without tangible physical securities so interest capping will not heighten demand for collateral as some are arguing.
“Banks will still demand the same securities. But what this means is that the banks will have to equitably share their profits with depositors. If you are cattle farmer you feed the cows well so that they can give you abundant milk to sell.
“The 5% margins will ensure that banks make normal profits and cartel lavishness of managers and directors and put more money into the depositors’ pockets. Higher deposit interest rates will attractive more depositors and banks will have more money to lend out.
“Lending, which is the core business for banks will not be profit based/driven but volume lending based. Because of high deposits, banks will have enough liquidity to lend more because demand for borrowing will be heightened. Because of this higher demand for loans banks will still make their profits.
“People in the villages cannot borrow to improve their agriculture productivity because they fail to pay back the costly loans. Interest capping for micro finance institutions will mean more borrowing of our people for small scale businesses and agricultural growth.”
Mukumbwa continues to say because of low interest rates and ceiling set at capital borrowed repayment will be easier and bad debts will be low. Currently repayment of loans is not attractive because your repayments are in perpetuity. This has resulted in serious bad debts registered by banks.
“Some people are saying banks will close down. Let the strong and ethical banks survive. We are simply overbanked — over 10 banks in this small and poor economy is madness. I know bank managers will be up in arms against me and bring in economic and financial services jargons to confuse people and our MPs.
“But the bottom line is that banks and the Central Bank have helped killing entrepreneurship in Malawi through exorbitant and punitive interest rates. So many SMEs cannot start or have closed down due to interest rates that look fine when you borrow but quickly turn into loan sharks. Let sanity return to the banking sector.
“Let MPs vote wisely otherwise if you say NO to the Bill you will be saying NO to our votes for you in May 2019,” he said.
Commenting to this statement on social media one person asked what will be the effect on the bottom line for the banks and the resultant impact on depositors. Will it trigger borrowing, savings, investments or inflation?
“The bill looks Ok but I would rather leave commercial banks do what they must. Rather, it would be good to open a Development Bank where these ceilings would apply,” he said.
Kenya-based banker Ben Wandawanda said Interest Rate Capping became effective in September 2016 in Kenya and applied retrospectively to loans and deposits already in bank books.
“The immediate effect was that a lot of earnings were wiped off banks’ earnings and some smaller banks immediately stopped lending. In fact some of them ‘refused’ to apply the law/new rates and instead asked their customers to move to other banks where they could enjoy the new rates.
“Some banks have practically closed (granted at the beginning of 2016 Kenya had 42 banks, over 30 micro finance institutions and many fintechs) and several mergers and acquisitions being explored.
“The approach is similar to what is being propagated in this proposal where a ceiling was set for lending rates and a floor was set for interest payable to deposits. Unfortunately the spread between these two limits in Kenya was not adequate for banks to apply ‘risk based pricing’ where as a consequence, for example, a corporate entity with good financials, account conduct and security would in theory be charged an interest rate similar to someone applying for an unsecured loan.
“The reaction was that many banks revised their risk appetites and stopped lending to ‘the bottom of the pyramid’ and SMEs and resorted to corporates and government lending where recovery rates are nearly 100% and applicable rates were near the cap historically.
“Knowing that SMEs drive economies the world over, a slow down in the Kenya economy has been visible compared to its neighbors where economic growth has been nearly double Kenya’s own growth.
“Besides reacting to the interest rate capping, the new accounting standard, IFRS 9 also because effecting in January 2018. This meant that as an entity/individual is granted a loan on day 1, banks had to make a signification provision for it in their books (assuming that a significant portion of the loan would not be recovered and setting aside funds to pay back to shareholders to ensure they don’t lose their money).
“These two factors combined have affected availability of banking facilities to the common man. This has shifted the market to fintechs because this regulation somewhat spared them as they do not take deposits and do not require banking licenses.
“They continue to lend at an average of 1-2% daily and claim that they do short term loans which if repaid in 7-14 days still remain cheaper (debatable really because most of their customers basically go to another FinTech to borrow and repay the existing loan — a vicious cycle).
“The World Bank and the IMF have been demanding that government removes the caps but MPs will not support this removal, meanwhile the Central Bank is working on a new ‘reference rate’ for banks to use to ensure interest rates don’t go through the roof again (prior to the cap, rates were as high as 28% and now with the cap the max is 13%).
“All in all, the intention of the framers of such a proposal may be noble, but it is best to deal with ‘the problem’ (and I may not know what this is for Malawi) and not the symptom because interest rate caps have proven to be counter-productive.
“Zambia tried it and the economy suffered until a hybrid of sorts and other different regulation was applied. A lasting solution could be a blend — a development bank/government bank could also be part of the solution but all in all, this whole thinking requires adequate research and simulations because the economic fundamentals will always be different from country to country,” Wandawanda said.